The resurgence of large leveraged buyouts is prompting US investment-grade debt investors to insist on more protection in some new issues. Investors have refused to buy some high-grade bonds in recent weeks because deals did not offer the necessary structural protection, and this sort of activism is expected to rise.

"We are clearly in a leveraged buyout-friendly environment, and definitely there is investor focus on structural protections against LBOs in high-grade deals," said one senior banker.

"There have been deals recently where large investors have decided to walk away, or threatened to do so, if there was no change of control put included in the structure."

On January 30, there was talk that a large investor had refused to take part in a US$400m 10-year offer from A2/A rated Air Products & Chemicals because it did not contain change of control language.

A similar threat was also reportedly made, but not followed through on, when Emerson Electric on February 15 approached investors with a US$500m 10-year trade.

Bankers said investor demands for change of control puts had increased along with the risk of companies being acquired by private-equity players through debt-funded buyouts.

Buyouts, although positive for equity prices, are detrimental for bond investors as they increase the acquired company's leverage and pull down its credit ratings. Change of control puts allow buyers to sell bonds back to an issuer at a price slightly above par if the company is acquired.

"Increasingly, bond investors are being squeezed from all sides, given the expected rise in interest rates and now this rise in LBO risk," said Marc Fratepietro, co-head of US investment-grade debt coverage at Deutsche Bank.

"There is indeed more investor focus on analyzing which companies could be the next LBO targets in the wake of these larger deals, and what legal provisions exist in those issuers' bond documents to protect from such an event."

CHANGE IN SENTIMENT

Three large buyout announcements since January have brought about the change in investor sentiment.

The first dent to investor pockets came in January when Michael Dell, teaming up with private-equity firm Silver Lake and software maker Microsoft, offered to buy out Dell Inc in a US$24.4bn deal.

Weeks later came news that John Malone's Liberty Global was buying Virgin Media for about US$15.75bn in stock and cash; and then Berkshire Hathaway and 3G Capital teamed up to buy Heinz for US$28bn, the largest leveraged financing acquisition since the financial crisis.

"There is more investor focus on analyzing which companies could be the next LBO targets in the wake of these larger deals and what legal provisions exist in those issuers' bond documents to protect from such an event."

Rating agencies downgraded ratings on the three companies and their outstanding bonds were hit badly. Fitch, for example, cut its rating on Heinz to junk and placed it on negative watch, saying that additional downgrades could occur. Moody's and Fitch downgraded their ratings on Dell to Baa2 and BB+, respectively.

Dell's long-dated outstanding bonds took a hit of between 10% and 20% immediately following the leveraged deal announcement, as none of the outstanding bonds carry a change of control covenant. Dell's five-year CDS had blown out 212bp to 409bp as of the close on February 21.

The change in the price of Heinz bonds depended on which of them contained the change of control language. According to UBS, four of the 10 outstanding Heinz bonds were unprotected, resulting in a price drop of between 6% and 15%, while bonds with relevant covenants saw only marginal price declines.

IDEAL CANDIDATES

The CDS levels of names such as Staples, Whirlpool and Kohl's are already trading in a way that reflects a potential buyout transaction. Many of these companies have been mentioned in research reports as ideal LBO candidates for their attractive cashflows, low leverage, and mid-cap size of between US$10bn and US$15bn.

Although bankers still expect a rise in the proportion of deals with change of control puts included, they argue that investors need to temper their expectations, as not all highly rated companies would be willing to accept such restrictions.

In 2012, about 21% of all investment-grade bonds allowed investors to put the bonds to an issuer at a price of 101 if the company were to be acquired, according to IFR records.

So far this year, only 17% of high-grade deals - US$24.03bn out of a total of US$143.3bn - have included such language, but this percentage is likely to rise significantly in the wake of the jumbo LBOs.

With many investment-grade bonds trading well above par, investors still stand to lose in the event of a takeover if puts are set at 101. This has seen investors explore the option of requiring puts at higher levels. But according to Hans Mikkelsen, a credit strategist at Bank of America Merrill Lynch, such demands may make less sense now than they did in 2012.

"Pushing the put level higher from 101 may not be completely logical because, unlike 2012 when bonds pushed out to 120-130, new bonds in a more normal environment will be trading in a 95-105 range, which is closer to the current put level," he said.